The Fed's monetary policy toolbox |
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Reserve requirements: Reserve requirements are the percentage of certain types of deposits that banks must keep on hand in their own vaults or on deposit at a Federal Reserve Bank. The Fed has the authority to set reserve requirements on checking accounts and certain types of savings accounts.
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| Reserve requirements |
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| Reserve requirement |
Impact on bank lending |
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The Fed rarely changes the reserve requirements. Changes in the reserve requirement make planning difficult for lenders, and any increase imposes a cost on them. The Fed generally does not change the reserve requirement when there is an alternative way of achieving the same policy.
Discount window lending: Federal Reserve banks lend to depository institutions at the discount window. The discount rate refers to the interest rate that the Fed charges banks for short-term loans. Changes in the discount rate typically occur in conjunction with changes in the federal funds rate. All depository institutions that maintain transaction accounts or nonpersonal time deposits subject to reserve requirements are entitled to borrow at the discount window.
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| Discount window lending |
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| Discount rate |
Impact on economic
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Monetary policy |
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"The Fed's monetary easing has been reflected in significant declines in a number of lending rates, thus offsetting to some degree the effects of the financial turmoil on financial conditions. However, this offset has been incomplete. In addition to easing monetary policy, the Federal Reserve has worked to support the functioning of credit markets and to reduce financial strains by providing liquidity to the private sector. In doing so, the Fed has deployed a number of additional policy tools, some of which were previously in the toolkit and some of which have been created as the need arose."
Term auction facility, or TAF:
This is a credit facility that allows depository institutions --
commercial banks -- to borrow from the Fed for up to three months
against a wide variety of collateral. For the period of this loan,
the action increases the Fed's assets and liabilities by the same
amount. These actions, though, would have the secondary effect of
increasing bank reserves and ultimately the monetary base. In general,
the Fed conducts open markets operations to counteract unwanted
increases -- or decreases -- in the monetary base. (Announced Dec.
12, 2007)
Term securities lending facility, or TSLF: This facility allows primary dealers to borrow Treasury
securities against other securities as collateral for 28 days. The
range of securities that can be used as collateral is wider than
for the TAF. For example, it includes some mortgage-backed securities.
The TSLF is a "bond-for-bond" form of lending, and it affects only
the composition of the Fed's assets without increasing total reserves.
Primary dealers are broker-dealers that trade in U.S. government
securities with the Federal Reserve Bank of New York. (Announced
March 11, 2008)
Primary dealer credit facility, or PDCF: This is an overnight loan facility that provides
funding for up to 120 days to primary dealers in exchange for collateral.
The PDCF accepts a broader range of securities than the TSLF and
is a "cash-for-bond" form of lending. To prevent PDCF operations
from increasing the monetary base, the Fed offsets the increase
with a sale of Treasury securities. (Announced March 16, 2008)
The differences in these instruments are types of
acceptable collateral, duration of the loan, which financial institutions
have access and the cost to the borrower. All these actions distribute
liquidity to the segments of the financial markets facing shortages,
but, because they merely change the composition of the Fed's assets,
they do not increase the monetary base.
On the other hand, this reallocation of assets may
reduce banks' demand for excess reserves and thereby encourage banks
to lend more.
"The provision of ample liquidity to banks and
primary dealers is no panacea. Concerns about capital, asset quality
and credit risk continue to limit the willingness of many intermediaries
to extend credit, even when liquidity is ample. Providing liquidity
to financial institutions does not address directly instability
or declining credit availability in critical non-bank markets such
as the commercial paper market or the market for asset-backed securities.
To address these issues, the Fed has developed a second set of policy
tools which involve the provision of liquidity directly to borrowers
and investors in key credit markets."
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